Nov. 5 (Bloomberg) -- Ambac Financial Group Inc.'s bond insurance rating was cut four levels by Moody's Investors Service, forcing the company to post collateral and causing a cash shortfall of about $3 billion at its investment unit.

The insurance financial strength rating was cut to Baa1 from Aa3 to reflect ``Ambac's diminished business and financial profile,'' New York-based Moody's said in a statement today. The outlook for the ratings is ``developing,'' Moody's said.

Ambac's guaranteed investment contracts require it to terminate transactions or post collateral if it is downgraded. That could leave the company with a cash shortfall of at least $2.8 billion, based on figures released today after the company reported a $2.43 billion net loss. Ambac Chief Executive Officer David Wallis told investors today the company would seek regulatory approval to shift money from its insurance arm to the financial services unit to bridge the gap.

``We continue to work closely with our regulators to receive permission to use the resources of Ambac Assurance to support this liquidity issue,'' Ambac Chief Financial Officer Sean Leonard said on a conference call.

Vandana Sharma, a spokeswoman for Ambac, declined to comment on the Moody's cut. Jim Guidry, a spokesman for Wisconsin's insurance department, said he didn't have a comment on whether the regulator would approve money being moved.

Third-Quarter Loss

Ambac said today it took third-quarter charge of a $2.7 billion to reflect a decline in the value of securities it had guaranteed using credit-default swaps. That type of mark-to- market loss, which doesn't always indicate an expected cash payment, this time forced the bond insurer to set aside about $2.5 billion to make good on those contracts, according to the statement.

Ambac also took a charge of $607.7 million for expected claims on bonds backed by home equity loans.

Moody's cited four reasons for its downgrade. The ratings company said it anticipates increasing losses from mortgage debt. If the economy worsens even more, creating an ``extreme stress'' scenario, those losses could be even higher, Moody's said. The company also faces diminished business prospects and impaired ``financial flexibility,'' Moody's said.

`Negative Pressure'

``Ambac's insurance financial strength rating remains investment grade reflecting the rating agency's view that Ambac's aggregate resources provide a meaningful capital cushion above expected loss levels,'' Moody's said. ``Should Ambac's regulatory capital position continue to deteriorate, there would be further negative pressure on the firm's ratings.''

Ambac and the rest of the industry have posted record losses after expanding from guarantees on municipal bonds that rarely default to insuring securities tied to mortgages that are now going delinquent. Ratings companies downgraded about $118 billion of prime-jumbo and Alt-A bonds in September following a record $200 billion of downgrades in August.

Moody's and Standard & Poor's stripped Ambac and MBIA Inc. of their top ratings in June. Moody's also has MBIA's A2 rating on review for a downgrade. S&P rates Ambac AA and MBIA AA.

MBIA today reported a reported an $806.5 million net loss after setting $961 million aside for guarantees on bonds backed by home-equity loans.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net; Christine Richard in New York at crichard5@bloomberg.net

Last Updated: November 5, 2008 17:55 EST